This is a transitional market to start 2005

Health care looks good, with broad markets in flux

Editor's note: This is a special edition of The Technical Indicator, a daily CBS MarketWatch service. It's now available at a monthly rate; Learn more and subscribe.

CINCINNATI (MarketWatch) -- The markets' performance in January came as a surprise to most investors.

The last time the S&P 500 and the Dow Industrials started January with three straight down weeks was 1977. And since its inception in 1971, the Nasdaq has never started January with three down weeks -- at least not until this year.

So it isn't surprising then, that coming into February, the markets have already carved out respectable losses. From top to bottom, each index has suffered the following decline:

The Nasdaq lost as much as 183 points, or 9.1 percent.

The Dow Industrials dropped 499 points, or 4.6 percent.

The S&P 500 lost 54 points, or 4.4 percent.

Yet January's anomalies don't stop with the size of the losses, they also tie into the manner in which they occurred.

This first chart above is a daily chart of the Nasdaq that goes back six months.

Recall that by the end of 2004, the Nasdaq had staged a sizeable rally from the mid-August lows. From bottom to top, it had run 25.2 percent in just over four months, placing the index at three-year highs.

Yet in the wake of those gains, the Nasdaq sold off considerably to start January. The sell pressure was so extreme, that in just three sessions, the index had moved from three-year highs to a posture under its 50-day moving average.

Again, it was the way it sold off in early January that raised a flag to the prospect of deeper losses. Those warning signs were initially touched on in The Technical Indicator on Jan. 4 and Jan. 5.

Still, by month's end, the Nasdaq had finally attracted buyers around the 2,000 level.

Take everything together, and after rallying 25.2 percent from the August lows, the Nasdaq ultimately suffered a 9.1 percent loss in January, before stabilizing just above support at 2,000.

The story on the Dow Industrials is similar to that on the Nasdaq.

Again, by year's end the Dow had already staged an impressive rally from its October lows. From bottom to top, the index had run 1,160 points, or 11.9 percent, in just over two months.

That rally set the stage for early January, in which the index came under severe sell pressure. In just seven sessions, the Dow moved from three-year highs to a posture under its 50-day moving average.

Yet like the Nasdaq, the Dow attracted buyers late in the month around support at 10,360 -- a level that matches roughly with the Dow's September high. The September high came in at 10,363, and the January low came in at 10,368.

Not surprisingly, the S&P 500 has a story similar to that on the other indexes.

Again, the S&P rallied sharply from the August lows before topping out in early January.

Then in late January, the S&P stabilized just above support at 1,160. The significance of that 1,160 support point is slightly more convoluted, but it was touched on in almost too much detail in The Technical Indicator on Nov. 30.

Take the three indexes together, and each staged an impressive rally late in 2004. Recall the markets really took off in early November, once the U.S. presidential election was determined.

Then in January, the indexes consolidated those gains with an unexpected, though decisive, move lower.

Looking ahead

So looking ahead, one important question is which move is dictating current market direction -- the late 2004 rally, or that unexpected sell off in January?

For better or worse, the answer to that question is not yet entirely clear.

Yet it's worth noting that the current fundamental backdrop is not altogether different than the prevailing backdrop in late October -- the period just before the U.S. presidential election.

That's because between the last week in January, and the first week in February, there are several catalysts that could dictate the next market move. These include the following upcoming events:

The Fed's decision on interest rates the first week of February.

The meeting of the G7 nations, also the first week of February. This is the first time China has accepted an invitation to the G7, and the hope is to discuss currency reform.

The first quarter meeting of OPEC in which crude oil production was not cut this past weekend.

The highly publicized Iraqi election.

Now any individual event above is clearly less impactful than the U.S. presidential election. Yet take the group as whole, and with the proper turn of events, they could definitely throw a big wrench in commodities, currencies and/or equities.

Health care as a defensive alternative

All this leads to an obvious question -- with the broad markets in flux, and with several important catalysts in the immediate future, how do you make money in this market?

One valid approach would be to abandon the top-down market analysis, and instead, start from the bottom up as a stock picker. No matter how adverse the backdrop, there are always individual success stories.

Yet if you were absolutely forced to seek out attractive sectors, there is a handful worth a look despite the shaky start to January.

Among these are the health care names. In times of uncertainty, health care tends to be attractive because the demand for those services is less price elastic. It doesn't boom or bust with economic cycles.

And from a technical standpoint -- the way the charts are shaping up -- the sector has held up in January as you might expect.

This next chart above illustrates the one-year performance of the Morgan Stanley Health Care Provider Index.

Notably, the index made five-year highs in January despite the steep slide carved out by the major averages.

The move follows a sharp rally spanning November and December, and a successful test of the breakout point around 385 to 390.

And in keeping with the top-down approach, there is a subset of health care names outperforming this already strong sector -- namely, the hospital operators. Again, with hospitals, demand tends to hold steady regardless of the economic backdrop.

The group rallied sharply in early January after HCA guided its fourth-quarter earnings outlook higher. Since then, each has sustained its break higher, maintaining a stance near 52-week highs.

Recall the bullish outlook for health care generally -- and the hospital operators specifically -- was initially addressed in The Technical Indicator on Jan. 18.

What does this mean for February?

For the time being, this is a market in transition.

From a broad market standpoint, it's the strength of this lift from the January lows that should indicate whether the recent upturn is a merely corrective bounce, or a sustainable upturn to be taken more seriously.

Yet while the markets sort through several upcoming catalysts, the health care sector has made five-year highs in January, and is attractively positioned to extend those gains.

Editor's note: This is a special edition of The Technical Indicator, a daily CBS MarketWatch service. It's now available at a monthly rate; Learn more and subscribe.

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